The Trump Tax Reform Plan, presented on April 26, does not have many details as yet, which left the market with many unanswered questions.
In our view the plan’s five major elements are as follows:
- A proposed corporate tax rate cut from 35% (currently the highest among OECD countries) to 15% (among the 5 lowest rates of OECD countries)
- A reduction in the number of personal tax brackets from seven to three: 10%, 25% and 35%;
- Taxing the pass-through businesses at 15% (it was not mentioned in thedocument, but discussed by Steve Mnuchin, US Secretary of the Treasury);
- A tax on repatriated profits (the only compensating item in the plan);
- The introduction of a territorial tax system. However, no reference to the Border Tax Adjustment.
All in all the economic impact of the plan is not easy to estimate given the lack of detail, but it is set to be significant and will certainly be a boost for the economy in the short-term, although will likely worsen the deficit outlook. The medium to long-term evaluation of such reforms is much more complex to assess. In fact, this expansionary plan fits in an economy already running close to full employment, with the consequence of putting further pressure on inflation and increasing debt to a level that could weigh on future growth potential. In short, we expect significant changes to the final version of the plan.
Have financial markets already priced in Trump’s tax reform?
In general markets have anticipated higher inflation and a stronger US economy since Trump’s election in November; although this reflation trade lost some steam recently amid evidence of weaker economic data and lower oil prices.
The initial market reaction to the tax plan was muted. In our opinion, the market has not priced much of tax reform yet as very few details are known and the proposal will have to pass through Congress, where Trump’s record has not been great so far.
In fact, this initial document is essentially the wish list of the President, but many of the proposals are unlikely to find support in Congress because they are not budget neutral and could significantly expand the deficit. Our view is that the market has priced no more than 10-20% of the value of the proposed cuts and we tend to agree with the market since there is not room to price more than that at this point.
If Trump succeeds with this reform, what impact could it have on US equities?
A huge reduction in corporate tax will be, by definition, beneficial to the equity market in the US. If the reforms are approved as proposed, we could see as much as 25%-30% growth in earnings over the next three years (less taxes and higher growth). Consequently, we believe that the equity market could go up by a similar amount. If enacted the tax plan will also benefit not only US equities but many global multinationals with large US businesses. It will also set a trend – for instance, Macron in France is now talking of tax cuts.
How is the market reacting to Trump’s first 100 days?
We believe that the market is correctly pricing Trump’s first 100 days. He has already started to move domestic investments in the energy sector and to reduce the negative impact of excessive regulations. But this is only an appetizer. The real question will be: can his tax reform succeed? More clarity on size and belief in his ability to deliver the plan could trigger further market appreciation, but until then markets may remain in wait and see mode, focusing on current earnings perspectives and fundamentals. While we wait, Q1 is shaping up to be one of the best quarters in the last 5 years in terms of earnings growth.
Marco Pirondini is head of US Equities at Pioneer Investments